Cash in on the Recovery

A glimmer of hope for the economy translates into big gains for stocks. It's not too late to buy.

By Andrew Tanzer, Senior Associate Editor

From Kiplinger's Personal Finance magazine, July 2009

The U.S. remains mired in what will likely enter the history books as the longest and deepest recession since the Great Depression. But there are signs the cycle is turning. Prices for economically sensitive commodities, such as copper and oil, have bottomed. Credit markets are returning to life. Businesses have slashed inventories, which will eventually have to be restocked. Confidence among consumers and business executives is rebounding from extremely depressed levels. The rate of decline in housing prices appears to be slowing.

The strongest hint of change may be coming from the stock market. From its March 9 close through May 8, Standard & Poor's 500-stock index soared 37%. Skeptics say the rousing rebound is nothing more than a bear-market rally. But it's hard to ignore an advance of such magnitude, especially when combined with solid indications that an economic bottom is at hand (for a look at some key signs, see How to Spot the Bottom). "A few months ago people worried about the survivability of the financial system," says William Greiner, chief investment officer of UMB Asset Management. "Now they focus on when the recession will end."

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After plunging 25% in the opening ten weeks of 2009, the market was flat for the year as of May 8. We still think there is a good chance that U.S. stocks will finish '09 with a gain of 5% to 8%, as we predicted in our January Outlook 2009 story. The Dow Jones industrial average, which closed at 8575 on May 8, could hit 9500 during 2009. That would be welcome relief from a harrowing 17-month-long bear market that pummeled stocks by 55%.

In many ways, the U.S. government contributed to the made-in-America financial crisis. It did so through excessively lax monetary policy, irresponsible promotion of a reckless subprime-mortgage industry, and a failure to properly regulate banks and other financial institutions. But give Uncle Sam his due for preventing a financial collapse that could have resulted in the economy falling into an abyss. "If the government did anything right, it was able, through a series of actions, to keep people from ultimate panic," says David Ellison, chief investment officer for the FBR Equity funds.

Greiner thinks President Barack Obama's administration deserves credit for restoring stability by pushing through the stimulus bill and coming up with plans to cleanse the clogged arteries of the banking system. Although it will take time before the country feels the full effect of stimulus spending, the impact of such Obama policies as tax credits for first-time home buyers is helping to support the foundering housing industry. The stress test for banks, which resulted in a call for ten companies to raise capital, provided investors with some clarity about the industry's health. Of course, the Federal Reserve, which has essentially slashed short-term interest rates to zero and taken other actions to stimulate the economy and keep the banking system functioning, deserves credit as well.

Confidence factor

Ron Rimkus, senior vice-president of BB&T Asset Management, describes a struggle between powerful deflationary forces met by a huge response from government. Only recently has Rimkus started to believe that the government is finally winning the battle to reignite the economy.

And don't underestimate the role of confidence-building. Through his popularity, credibility and frequent public appearances, President Obama has helped a shaken population start to regain faith in the economy.

Regardless of whether Obama, by deed or word, helps end the recession, investors aren't waiting for official confirmation that the downturn is over. By returning in force to stocks and risky fixed-income investments, such as junk bonds, they clearly anticipate better times ahead, including a recovery by the end of this year. "Being a leading indicator, stocks can't wait for earnings and other economic indicators to be good," says Duncan Richardson, head of stock investments at the Eaton Vance funds.

Because of the March-May run-up, stocks are no longer the bargains they were in the depths of the bear market. As of May 8, the S&P 500 traded at a not-so-cheap 17 times projected operating earnings for 2009. Still, stocks will continue to climb if the economy does begin to grow later this year, helping to boost corporate earnings, which have been cut in half since peaking in 2007.

One bright spot is that interest rates are so low that cash and Treasury bonds offer little competition for stocks. Shellshocked savers have squirreled away close to $4 trillion in low-yielding money-market funds, savings that could flow into stocks if investors' confidence and appetite for risk continue to improve (for the fixed-income outlook, see Bargains Still Abound in Bonds).

Reasonable energy prices and record-low mortgage rates, as well as government spending, will aid beleaguered Americans. Richardson estimates that consumers will have an extra $500 billion in cash, thanks to the drop in energy prices and a new refinancing boom precipitated by declines in mortgage rates.

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